Estate Planning After the Cliff: What You Need to Know

On January 2, 2013, President Obama
signed the American Taxpayer Relief Act of 2012 (the "2012
Tax Act"), which retroactively extended most of the tax breaks for
individuals that expired on January 1, 2013. Most significantly,
the 2012 Tax Act eliminated the so-called "sunset provisions" of
the Economic Growth and Tax Relief Reconciliation Act of
2001 and the Tax Relief, Unemployment Insurance
Reauthorization and Job Creation Act of 2010, thereby allowing
individuals and their advisors to engage in estate planning without
the uncertainty caused by prior legislation.

Increase in Transfer Tax
Exemptions

The good news for taxpayers is that
the 2012 Tax Act permanently increased the exemptions for federal
estate, gift and generation-skipping tax transfer ("GST") tax.
Those exemptions, which will be automatically indexed for inflation
in future years, are currently $5,250,000 per person. In addition,
the 2012 Tax Act permanently retained the concept of "portability,"
which essentially allows a surviving spouse to use the deceased
spouse's unused estate (but not GST) exemption. The bad news is
that the top tax rate on gifts and bequests increased from 35% to
40%. As a result, taxpayers whose net worth exceeds the exemption
amount may have to pay more in tax under the new law.

Continuation of State Death
Tax Deduction

The 2012 Tax Act also permanently
converted the state estate tax credit to a deduction. As a result,
residents of states such as Illinois, which have a separate estate
tax law, may have a greater estate tax burden than residents of
other states. In addition, because many states, including Illinois,
have a lower estate tax threshold than the federal estate tax
exemption, it is a good idea to review your estate plan to be sure
that it addresses this differential. Many estate plans,
particularly those done prior to 2008, may not contemplate this
relatively recent adjustment in state laws.

Increase in Annual
Exclusion

Courtesy of the 2012 Tax Act,
donors of lifetime gifts may continue to apply the annual gift tax
exclusion before having to use part of their lifetime exemption.
For 2013, that inflation-adjusted annual exclusion amount is
$14,000 per donee. Married couples may continue to "split" their
gifts and may make combined gifts of $28,000 to each donee.

AMT Fix

On the income tax side, the 2012
Tax Act eliminated the perennial adjustments to the alternative
minimum tax (AMT), by indexing the exemption amount to inflation.
The Act retroactively increased the exemption amount from $33,750
to $50,600 for single filers and from $45,000 to $78,750 for
married taxpayers filing jointly. However, AMT will still continue
to affect a great number of high income taxpayers.

Discharge of Indebtedness
Exclusion

The 2012 Act provides a one year
extension of the exclusion of up to $1,000,000 of discharge of
indebtedness income relating to a taxpayer's principal residence
($2,000,000 for married taxpayers). Debt forgiven in connection
with a foreclosure, as well as debt reduced through mortgage
restructuring, qualifies for the relief. However, the exclusion
only applies if the discharge is directly related to a decline in
the home's value or the taxpayer's financial condition.

Qualified Charitable
Contributions from IRAs

The 2012 Tax Act temporarily
extends the ability of individuals aged 70½ or older to make a
direct transfer from an IRA to a charity of up to $100,000 per
year. The Act also allows charitable distributions from IRAs that
are made prior to February 1, 2013 to be deemed to have been made
in 2012. In addition, the Act provides taxpayers with a temporary
window of opportunity to treat any portion of a distribution from
an IRA in December 2012 as a qualified charitable distribution it
is donated to a charity (in cash) before February 1,
2013.

Income Tax Rate
Hike

Tax rates for the vast majority of
taxpayers were unchanged. However, a new top income tax rate of
39.6% will be imposed on taxable income over $400,000 for single
taxpayers and $450,000 for married taxpayers filing jointly. In
addition, a new 20% tax rate applies to capital gains and dividends
for individuals in the highest income tax bracket. Taxpayers who
are in the 25-35% income tax rates remain subject to a 15% capital
gains tax rate, and those in the 10-15% tax rate do not pay any
capital gains tax.

FICA Tax Hikes

Unfortunately, the 2% payroll tax
holiday, which was in effect for 2011 and 2012 has not been
extended. As a result, the tax rate on the employee's portion of
Social Security and self-employment taxes has reverted to 6.2%. The
Act also imposes an additional Medicare Tax of 0.9% on taxable
wages in excess of $250,000 in the case of a married taxpayers
filing jointly and $200,000 for single taxpayers.

Additional Medicare Tax on
Investment Income

Also coming into effect in 2013 is
the unearned income Medicare contribution tax, which was enacted as
part of the Affordable Care Act of 2010. This tax is an
additional 3.8% of the lesser of a taxpayer's: (a) net investment
income for the year; or (b) modified adjusted gross income over a
certain threshold amount (which is currently $200,000 for single
taxpayers and $250,000 for married taxpayers filing jointly).

For Your
Consideration

While the 2012 Tax Act did not
address all of the financial issues relating to the so-called
fiscal cliff, many of the tax provisions that were scheduled to
revert back to pre-2001 levels as of January 1, 2013 were extended
indefinitely, including the transfer tax laws. Tax law changes are
a good impetus to review your planning needs. As a general rule, we
recommend that you contact us if: (1) your estate plan is more than
5 years old; (2) you own substantial life insurance in your own
name; or (3) you have had a major change in your financial position
or family situation. Your HMB attorneys are happy to answer any
questions you have about the 2012 Tax Act or your estate and tax
planning needs.

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